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Derivative Asset Pricing With Transaction Costs

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Listed:
  • Bernard Bensaid
  • Jean-Philippe Lesne
  • Henri Pagès
  • José Scheinkman

Abstract

In the modern theory of finance, the valuation of derivative assets is commonly based on a replication argument. When there are transaction costs, this argument is no longer valid. In this paper, we try to address the general problem of finding the optimal portfolio among those which dominate a given derivative asset at maturity. We derive an interval for its price. the upper bound is the minimum amount one has to invest initially in order to obtain proceeds at least as valuable as the derivative asset. the lower bound is the maximum amount one can borrow initially against the proceeds of the derivative asset. We show that, in some instances, this interval may be strictly bounded above by the price of the replicating strategy. Prima facie, the cost of a dominating strategy should appear to be higher than that of the replicating one. But because trading is costly, it may pay to weigh the benefits of replication against those of potential savings on transaction costs. Copyright 1992 Blackwell Publishers.

Suggested Citation

  • Bernard Bensaid & Jean-Philippe Lesne & Henri Pagès & José Scheinkman, 1992. "Derivative Asset Pricing With Transaction Costs," Mathematical Finance, Wiley Blackwell, vol. 2(2), pages 63-86.
  • Handle: RePEc:bla:mathfi:v:2:y:1992:i:2:p:63-86
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    File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1467-9965.1992.tb00039.x
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    References listed on IDEAS

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    1. Bernard Dumas & Elisa Luciano, 1990. "An exact solution to the portfolio choice problem under transactions costs," Working Papers hal-00612308, HAL.
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